This episode is titled “Ep #157: A Candid Conversation Regarding Capital Raising with VerifyInvestor.com Co-Founder, Jor Law.” It includes an excellent explanation of the SEC exemption Regulation D 506(c) and why Louisville startups should embrace and use this exemption to raise capital.

Key points:

If you’re going to raise capital for your startup company, or any other company, you need to notify the SEC, and you need to select the proper filing.

Regulation D 506(b) is the most common exemption. It allows you to raise an unlimited amount of capital from accredited investors and up to 35 non-accredited investors per year. However, it requires that you raise the capital through your own private networks with no general solicitation. In other words, you cannot advertise or tell anyone publicly about your capital raise. (By the way, if you ask for money at a demo day or pitch contest, you’re likely breaking SEC law.)

Accredited Investor – Generally, to be an an accredited investor, a person must demonstrate an annual income of $200,000 (or $300,000 joint income with their spouse) for the last two years with the expectation of earning the same or higher income this year. Or, the person may have a net worth of $1 million, excluding the value of their primary residence. (Click here for a full definition.)

Regulation CF – This is the newest kid on the block. It allows you to file and raise capital through licensed portals (such as WeFunder.com). Under this type of capital raise, you can raise capital from any type of investor (accredited or non-accredited). You also can advertise your capital raise as much as you like. However, you can’t advertise the terms of your raise with the exception of a limited landing page directing people to the portal of your choice. You also have to be very cautious to avoid promising your potential investors too much. In addition, you can only raise $1 million per year, you have to disclose detailed specific information about your business, investors are limited in the amounts they can invest, your funding portal has to escrow the money, and you have to return all your cash, if you don’t reach your preset minimum. Finally, you have to submit annual filings to the SEC, and you have to divulge a good bit of info on your company to the general public (including your competitors). This type of capital raise is fantastic in certain situations, and we should be embracing it, when it makes sense.

Regulation D 506(c) – This exemption took effect in 2013. It has not been widely embraced, but it’s incredibly powerful. It allows you to advertise with very little restrictions; but, of course, you cannot provide fraudulent statements to potential investors. The main caveat of this type of exemption is that you can only accept accredited investors, and you have to verify that your investors actually are accredited.

Verification of investors is the main reason most people feel that it hasn’t taken off. The verification process is not difficult, but you have to be very diligent about doing it. It can be as easy as a 5 minute process for the investor utilizing a service like VerifyInvestor.com. Or, you simply can ask your investor to submit a verification statement from their lawyer, accountant, broker, or wealth manager. The guys on the podcast linked above have a lot of experience with the 506(c) exemption, and they believe it’s the way of the future. Investors need to get used to verifying their accredited status and embrace the whole process because it will open them to more and better deals!

Where this exemption has been embraced, it has worked well, and I believe LOUISVILLE SHOULD GET COMFORTABLE WITH IT IT AS SOON AS POSSIBLE!!!

Why?

This exemption will allow us to reach a lot of potential accredited investors who currently don’t invest in startups. By some estimates, we should have as many as 56,000 households in the Louisville metro area that would qualify as accredited investors. The percentage of these people who actually invest in startup companies in our area is extremely small. If more of them invested, our startup community would accelerate dramatically.

You can password protect your offering and provide access only to approved potential investors (limiting access to your competitors). You also can provide any information you like to potential investors, and it is up to them to decide if you have provided them with enough information to answer their questions and entice them to invest.

Startup investing is pretty fickle. You can spend hours upon hours working your network and courting investors only to find that no one invests. Even if your business is absolutely fantastic, investors need to connect with and understand your concept, and they need to be in the immediate position of looking for investments. This really limits the pool of investors, especially if you’re talking to the small number of angel groups and investors in our community. So, connecting a larger pool of possible investors through some form of public advertising will help you reach the right people at the right time. Everybody wins.

Startup investing is a bit of a numbers game, and it can be very profitable. In fact, according to a study by the Kauffman Foundation (CLICK HERE), the average angel investor has a return of 27% per year (three times the S&P 500 average). However, in order to reach those returns, they have to invest in 10 or more startups. We need to make it easy for all of the startup investors in our community to invest small amounts in multiple startups in order to produce those kinds of returns. Our current small pool of angel investors can’t support the numbers game. We have to increase the pool of investors, let all startup investors better spread their risk (including the currently active angel investors in our community), and create enough startups to hit some big wins.

As we build a bigger and bigger audience of accredited investors through Regulation D 506(c) capital raises, we’ll build more and more awareness of our startup community. Then, startups who pursue the 506(c) capital raises can supplement their raises with Regulation CF raises and let the whole community in on it, including non-accredited investors.